The Future of Banking Will Be Defined by Efficiency

The awareness that technology not only will, but already is, shaping finance is undisputed, even by the most technology-shy firms. But it is time to reinvent the bank of the future rather than fix a model that is no longer fit for purpose. Here are three steps banks can take to prepare for what the future holds.

A few years ago, I talked about the fact the future of banking would be defined by technology. While the idea was certainly not new – especially for parts of the banking industry that already had seen technology-driven market making firms replace million-dollar traders – there were still parts of the industry that continued to resist change.

Today, the awareness that technology not only will, but already is, shaping finance is undisputed. Not a day goes by when a bank CEO does not talk about the organization’s commitment to innovation to address the challenges of the future. Unfortunately, for many in the industry, such talk is cheap. This is not to say that the intentions of those CEOs are not genuine – and that they do not intend to act on them – but rather that many organizations are simply trying to apply technology and innovation to a banking model which is no longer fit for purpose

While it is hard to see what the future will look like – and whether the current technological revolution will lead to the creation of handful of super banks (which are able to embrace innovation and compete in every single area of financial activity – a model currently followed by the exchanges), or whether we will have greater number of entities that will each specialize in a product area or service, there are a few things that banks can do to prepare for what the future holds.

First, they need to understand the limits of their legacy systems rather than protect them at any cost. It is not a stretch to say that the legacy issues that many banks face today are similar to those faced by the Olivetti typewriter or the now defunct Blockbuster. Understanding that those systems have reached the limit of their potential and that the cost of protecting them will continue to increase until it erodes the profits that currently support them is an important first step. You cannot innovate with Netflix in a Blockbuster branch or put a Ferrari engine in an electric car. In other words, when there is a paradigm shift in the industry – such as a streaming service replacing the rental of a VHS or DVD – there is nothing the incumbent can do.

Second, banks need to embrace innovation as a step change rather than as an incremental experience. This is an opportunity for banks to think about their business of the future as a zero-sum game. Making small changes in the hope of extending the life of existing business models will not future-proof growth and revenues – it will stifle them by supporting inefficient models that rely on employing huge swathes of people to deliver a service that is better delivered by technology. Banks can learn from the likes of Google (now Alphabet) and GE, whose leaders see incrementalism as leading to irrelevance – a daily reminder that to succeed in the era of technological efficiency banks need to be bold in both strategy and action. The bank of the future will need to embrace innovation fully – a website or sharing of files between legacy systems will not stop their demise. Neither will having big IT departments – all banks already do. It’s about being truly innovative, having an open architecture that will allow them to adopt changes in hours not months, that does not have siloes between jurisdictions, asset classes or front and back office.

Third, banks need to embrace responsibility and innovation to help them become better providers to their clients. If the banks continue to hold onto inefficient infrastructure such as branches, and continue to employ tens of thousands of people to hold on to that infrastructure – the cost of inefficiency will ultimately be borne by their clients in terms of higher fees, and their shareholders in terms of lower returns. Both are much more mobile than before and more likely to move their money elsewhere.

Some say that banks should turn into not-for-profit utilities. I don’t believe this is the case – there is still an optimal level at which banks can make money for their shareholders but also deliver value to their clients through technology. Being open to outsourcing or partnerships is one way to deliver this; buying an innovator or creating utilities with competitors to lower the overall costs of the infrastructure is another. Many banks have spent the time since the latest financial crisis building their capital base; however, at a time when there are greater than ever restrictions to banks’ activities, and more downward pressures on costs and margins, the inefficiencies risk eating into the banks’ capital and revenues.

Banks need to increase their efficiency ratios. To do so, they need to look beyond the short-term threat of fintech disruption to the customer experience, and challenge the entire value chain to make their institutions more efficient. There is a real opportunity for banks that are willing to read the tea leaves and prepare for a future in which their client base will be exponentially more empowered than at any other time in the banks’ history. It’s time for banks to act boldly.